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36K to 34K: Who moved my market?

Author: JK Jain/Saturday, March 17, 2018/Categories: Cover Feature

36K to 34K: Who moved my market?

The strong momentum which was built up in the month of December 2017 and even in the first half of the Jan 2018 made Sensex to conquer psychological levels very easily. However, some announcements in the Union Budget, weakening of macroeconomics, PNB Saga has made Sensex to decline and move back to 34,000.

On the flows front, all FIIs (Foreign Institutional Investors), domestic institutions and retail flows have slowed down for the month of February as compared to January. In the cash market segment, as on 21 February 2018 for the year, foreign players have pulled out more than Rs 2,452 cr for the year. In the month of February alone, they have pulled out more than Rs 12,000 cr, depicting their negative stance on our markets.

While domestic institutional participants continue to support our markets and they have bought more than Rs 11,000 crore for the year as on 21 February 2018. The key point to note here is, due to the recent turmoil and volatile moves in the markets, domestic investor sentiment too has taken a hit and the fresh money from retail investors  has slowed down. Nevertheless, the SIP money continues to be strong. Even on the derivative front by foreign institutional players, after one year of prolonged long side built up on index futures, long-short ratio surprisingly has skewed towards short side, indicating their change in stance.

Fight for Indian Data

The recent circular from the securities market regulator and the exchanges regarding the decision to stop sharing market data with foreign peers have sent a surprising signal to the global participants. The move is taken on account of increased trading activity and significant increase in Nifty OI at offshore and exchanges want to consolidate that liquidity. Most of the participants expect this attempt is likely to promote tax-free trading zone in the GIFT city.

Currently, Indian exchanges have data sharing agreements with SGX, CME Group, the Taiwan Futures Exchange and Osaka Securities Exchange. However, most of the foreign players, especially MSCI, has said that the following steps are anti-competitive, and disallowing the Indian markets from the free trade. They also cited the risk of foreign currency and the higher costs of trade impacting the liquidity under the new arrangements. This warning by MSCI has triggered doubts among participants that MSCI may reduce its weightage in the emerging market index which may impact more than 10 billion dollars of its investments in India. Moreover, the probable inclusion of China A shares in the coming months will also reduce the weight of India significantly. If India is dropped out of the Emerging Market Index, then there could be a very big repercussion.

PNB Episode: One-off case or Systemic?

One of the India’s biggest banking frauds in the second-largest PSU bank, Punjab National Bank has raised a lot of doubts on the surveillance and risk management techniques incorporated into the banking system. It also raised concerns over the expertise of top management as the fraud went undetected for last few years. The Rs 11,000-crore fraud has, especially, reaffirmed that public sector lenders are becoming victims of fraud at an alarming rate. The key point here is the systemic issue- whether this is one-off or are there many more such transactions in the system. The bigger problem is about the monitoring mechanism and checks and balances in the banking system. This point is being unattended and is not identified in a system where we use technology. These are the things which come into consideration as far as the future outlook is concerned.

Meanwhile, the regulator has stepped in to look into this issue and RBI is likely to tighten norms on foreign borrowing which can protect borrowers from shocks and in turn shall impact the exporters. The RBI has also formed a 5-member committee to look into the reasons for high divergence observed in provisioning and asset classifications and the steps needed to eradicate them such as: what are the factors leading to an increasing incidence of frauds in banks and the measures including technological interventions needed to curb and prevent it; and the role and effectiveness of various types of audits conducted in banks in mitigating the incidence of such divergence and frauds.

For now, it seems difficult for the lenders to recover the amount as we have seen in the recent instances. As Nirav Modi has left the country,   if the banks now failed to recover the major part of the said amount, it would wipe out all the profits made over last few years and also could lead to significant erosion of the net worth or tier 1 capital along with  deteriorating ratios.

In the recent quarters, most of the bank managements have been saying that bad loan cycle has plateaued, but their reporting numbers have shown increase in NPAs, suggesting that they are nowhere near the peak. Now RBI has passed new guidelines of restructured assets which means more provisioning is required for bad loan accounts. Under such circumstances, even the measures such as  announcement of recapitalization will also become futile unless  the amount of recapitalization becomes  doubled to nearly Rs 4.5 lakh crore. Moreover, the huge exposure of PSU banks in the G-Secs, and the recent increase in bond yields is also likely to negatively impact their profitability over the next few quarters. So, the PSU banks’ ability to grow or regain market share seems to be severely compromised, and any credit uptick will be largely taken over by private lenders.

All the above data points suggest and strongly reinforce the urgent need of reforms in PSU banking space by the government through  merger or privatization by allowing outside players  to have around 51% stake.

Going forward, most of the large banks showing stress are likely to  maintain the status quo for next two to three quarters with  sentiment on these counters remaining subdued. Within the banking space, those  private lenders who have improved their growth capital by selling stakes in subsidiaries, or who have the ability to raise funds through current and savings accounts or  through private placements are likely to gain more as  compared to  their peers in PSU space. Especially, the banks with more focus on retail lending than on corporate lending will see their margin improving even in the rising interest rate scenario. Hence, for the existing investors, with the recent sell off in the PSU Banking stocks, it may be too late to sell them at current levels. For fresh investors, it would be better to avoid PSU bank counters and they may look at their private counter parts for better return.

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